FINANCIAL SYSTEM IN CRISIS

Angst on Main Street

Mid-size businesses, already struggling to secure financing, could be hit by a further tightening of credit.

Small and mid-size companies that depend on banks for the money to help them grow are facing new challenges as the nation's credit crunch squeezes lenders and forces some to consolidate or even collapse.

On Monday the angst on Wall Street was no less palpable on Main Street.

A plummeting stock market, a failed investment house and talk of layoffs prompted new concerns about the months ahead and a shortage of money, whether it's to take companies public, to start ventures or to underwrite big expansions.

There was optimism as well as pessimism. Ultimately, many experts suggest, all of this financial turmoil will scrub rampant speculation out of the economy and restore discipline to lending. That should make it easier for businesses to fund internal expansions and to make acquisitions in their own industries. It's just going to be rough between now and then, they say.

The biggest concern for now is that banks worried about their balance sheets will decide not to renew loans, said Larry Harris, a finance professor at the USC Marshall School of Business. That could mean even a loan backed by solid collateral won't be renewed.

"The borrower won't find a new loan if all the other banks are doing the same thing. So the loan will go into default. This is everybody's biggest fear," Harris said.

There's no denying that business credit has dried almost to a trickle.

Dave Hall co-owns MotoArt, a Torrance manufacturer that takes vintage airplane parts and turns them into furniture. Hall and business partner Donovan Fell tried to obtain a $50,000 loan this year but were rejected by banks, which were in no mood to look at a pile of used aircraft pieces as collateral.

"We even had good credit ratings, but it is just impossible to get a line of credit right now," Hall said.

MotoArt eventually got its loan -- for two years at a 12% interest rate from a client, several percentage points higher than what a bank would have charged, Hall said.

The difficulty of finding financing is likely to vary widely among companies, depending on what business they are in, said Russell Goldsmith, chief executive of Beverly Hills-based City National Bank.

"If you are looking for funding for a speculative housing development, it will be extremely difficult, but a profitable small business should be able to get a loan on reasonable terms," Goldsmith said.

Still, there are "fewer lenders out there and they will be more prudent about who they loan to," Goldsmith said.

Jonathan Rosenthal, a partner at Santa Monica investment firm Saybrook Capital, agrees. "There's lots of companies that want money but not a lot of providers who want to lend money," he said.

And those that do have the cash to lend are likely to be stingy, something that will make it even harder for small and mid-size companies to raise capital, Rosenthal said.

"There is an incentive to hold cash in an environment like this, because if there are good deals now, there will be even better deals later," he said.

Eventually institutional investors such as retirement funds and insurance companies are going to have to find somewhere to park their cash, and that should be good for the economy.

They are likely to shy away from hedge funds and the private equity funds that have been so lavish with spending up until the start of the financial markets crisis, Rosenthal said. Instead, they probably will put money into funds that are buying up distressed businesses on the cheap or into public stock offerings for solid companies, he said.

This should also make it easier for well-managed businesses to make acquisitions in their own industries, said Richard Heckmann, a veteran executive who previously has headed sporting goods maker K2 Inc. and USFilter, a water company.

Heckmann said he sold Carlsbad, Calif.-based K2 last year because the combination of easy money and private equity funds were thwarting his plans to roll up small sporting goods companies into a fully integrated larger business.

"I was being outbid by the private equity funds by as much as 40% because they had such cheap money from the banks," Heckmann said.

Prices rose to a point far beyond economic sense. But Heckmann believes that that has come to an end and that the valuations for companies will drop to more reasonable levels. That will make it easier for companies to purchase businesses that will blend well with their operations, he said.

"Eventually this will be good for capital formation because we will be getting back to business," Heckmann said.

The lousy economy also has made it tough for companies to tap into another traditional source of raising capital -- selling shares of the business to the public. During the first half of this year only 36 companies completed first-time public stock offerings. That contrasts with 133 initial public offerings in the first half of 2007 and 273 IPOs through all of last year, according to Renaissance Capital in Greenwich, Conn.